Business Trends: Anticipated market and pricing impacts from new marine fuel regulations
In October 2016, the International Maritime Organization (IMO) announced that it will implement a new regulation that calls for the sulfur content in marine fuels to be reduced from 3.5% to 0.5%. The new regulation will go into effect in January 2020. This action by the IMO will have a profound impact on the maritime and refining industries worldwide, as well as on the environment. This month’s Business Trends section provides an overview on the anticipated impacts of the IMO’s decision on petroleum product markets.
At its MEPC70 meeting in October 2016, the International Maritime Organization (IMO) announced that it will implement the 0.5% Global Sulfur Cap starting on January 1, 2020. The new regulation is part of the MARPOL Annex VI regulation (FIG. 1).
Fig. 1. IMO MARPOL Annex VI sulfur limits.
In an effort to better inform the industry of the IMO’s decision, the authors delivered a rigorous analysis in mid-2016 on the likely implications of implementing the regulation in 2020.1 Decreasing the allowable percentage of sulfur in marine fuels consumed in international (non-emissions control area, or ECA) waters from 3.5% to 0.5% represents a profound change. Some observers have likened the Global Sulfur Cap to the recent change from 1% to 0.1% sulfur in ECAs, but the fact is that the Global Sulfur Rule is likely to have a magnitude ten times greater than that of the recent ECA rule, in terms of the volume of marine fuel that must be “switched” to the new standard.
The driver behind the MARPOL Annex VI rule is to potentially improve the health of millions of people, particularly those living in coastal areas. At the IMO’s MEPC70 meeting, it was clear that the group was keen to avoid the regulation being pushed back until 2025. Nonetheless, this step change in global marine sulfur limits will have major impacts on the maritime and refining industries worldwide, as well as on the environment.
Regulatory uncertainty has limited progress toward compliance
The MARPOL Annex VI Global Sulfur regulation is unique in the uncertainties it embodies. A five-year timing question—implement in January 2020 or delay until 2025—was settled at MEPC70.
However, compliance uncertainty remains, as shipowners can respond by purchasing 0.5% sulfur-compliant fuel, by installing onboard scrubbers and by staying with high-sulfur fuel, or they can switch to an alternative fuel, such as LNG. The timing and compliance uncertainties, along with a lack of incentive for either shipowners or refiners to pre-invest before the Global Sulfur Rule comes into effect, have deterred all parties from investing.
Limited LNG or scrubber penetration seen by 2020
LNG has virtually no sulfur and very low particulate and nitrous oxide (NOx) emissions. As such, it represents a potentially attractive fuel under MARPOL Annex VI; however, it suffers from the “chicken-or-the-egg” syndrome. Shipowners cannot justify investing in vessels capable of running LNG until the promise of LNG supply infrastructure is well established. Similarly, a reluctance is seen by companies to invest in LNG infrastructure until a sound demand basis is set from shipowners.
The authors’ view is that LNG will continue to gain ground as a fuel source for marine vessels over the long term, but will have limited market penetration by 2020. Alternative fuels, such as methanol, have also been discussed, but the potential is small, especially in the short term.
As a result of this scenario, switching to 0.5%-sulfur fuel or installing scrubbers are the primary options for compliance by 2020. Through a survey of Exhaust Gas Cleaning System Association (EGCSA) members, the authors found that only 346 vessels had scrubbers installed, or on order, through December 2015. Virtually all of the scrubbing systems were designated for use in ECAs. This vessel count represents a miniscule 1.4% of the 24,000 “candidate” ships worldwide that are economically suitable for scrubbers; in other words, a very small degree of progress has been made to date.
Via survey, modeling of scrubber technology takeup and allowance for manufacturing and installation limits, the authors estimate that scrubbers will be installed on, at most, 5,000 vessels by 2020. These vessels will consume an estimated 48 MMtpy (900 Mbpd) of high-sulfur heavy fuel oil (HS HFO). This assessment is close to the 36 MMtpy projected for 2020 by one IMO study,2 but well above the more conservative 11 MMtpy projected by a marine analyst.3
Uncertainties surrounding the use of scrubbers on ships are a factor affecting expected takeup. These include limited operating experience, management and disposal of acidic wash water, and concern over whether scrubbers will be able to meet more stringent emissions regulations in the future, should they be implemented. Prior to MEPC70, shipowners commonly expressed unwillingness to invest $3 MM–$8 MM to install a scrubber. Retrofitting is achievable, but is unlikely to be considered economic by the owner where the remaining vessel life is short or where vessel sale is anticipated.
In addition, the shipping industry is experiencing severe financial difficulties, based on vessel oversupply and trade uncertainties, and will need to deal with a new IMO Ballast Water Convention coming into effect in September. The net effect is that the bulk of the burden, from what is fundamentally a shipping-sector regulation, will fall on the refining sector—at least at the immediate onset of the rule in 2020. This situation also raises the question of whether the refining industry will be able to meet the demands placed on it by the Global Sulfur Rule.
The switch constitutes a major market impact
If the authors’ outlook holds true, the 2020 requirement will be to switch roughly 200 MMtpy (3.8 MMbpd) of HS HFO to 0.5% fuel, with a range of uncertainty of approximately +/– 10%. A forecast for all marine fuel types in 2020 is shown in TABLE 1.
The magnitude of a 3.8-MMbpd switch volume, and the corresponding market impacts, should not be underestimated. While economic incentives exist to produce heavier marine fuels to the 0.5% sulfur standard, the expectation is that these will initially play only a small role, partly because of the need to establish acceptability for onboard-ship operation. Testing new fuels can be done safely (shippers generally perform onboard fuel compatibility tests before committing to fuel use), but fuel compatibility is a concern for shipowners. Asphaltene-like sediment can form in fuel storage tanks and clog the ship fuel delivery system. According to Steve Bee, Global Business Director at Intertek ShipCare Services, the blending of two bunker fuels that are each perfectly within ISO 8217 specifications can lead to incompatibility and an unusable product. The risk, however small, of engine issues cannot be passed along in the same manner as fuel costs for vessels on term charter.
Fig. 2. Global marine fuel consumption in 2020 (excluding LNG).
Consequently, the authors see the bulk of the 0.5%-sulfur fuel as being marine distillate, especially in early 2020 (FIG. 2). The industry is facing a demand to convert nearly 4 MMbpd of HS HFO supply to much lower-sulfur fuel (mainly distillate) over a short period of time. This trend equates to a shock to the supply system. To put this into context, it equals:
- 8 yr–9 yr of past growth in (inland) gasoil/diesel
- Five years of growth (2015–2020) in total main light products (gasoline, jet fuel, kerosine, gasoil and diesel)
- A 45% reduction in total residual fuel demand.
Refining industry to the rescue? Hydrogen and sulfur plant limits foreseen
Will the refining sector be able to fully respond and meet the switch requirements on January 1, 2020? Evidence indicates that this is unlikely.
Through a compilation of data from Hydrocarbon Processing’s Construction Boxscore Database and other sources, the authors believe crude distillation capacity and secondary (upgrading) capacity to be adequate to fully respond to the Global Sulfur Cap in 2020. The authors also project that available desulfurization and hydrocracking capacity will be adequate to handle increased feed sulfur loads, albeit with potential strain and implications for catalyst life. The notable exceptions are sulfur recovery plant and, to a lesser degree, hydrogen (H2) plant capacity; both are vital for desulfurizing refinery streams.
The authors estimate that further additions, equating to 60%–75% over and above planned 2016–2019 projects, will be needed to meet the industry’s sulfur recovery needs; likewise, H2 plant additions of 20%–35% of firm projects will be needed. The authors estimate that SRU base capacity in 2016 was just over 128,000 short tons per calendar day (st/cd). Even with the additional 13,366 st/cd of SRU capacity that is likely to be added between 2016 and 2019, the authors believe that an additional 8,000 st/cd–10,000 st/cd of SRU capacity, above that which has already been announced, will be needed to meet the Global Sulfur Rule.
These findings are based on rigorous, integrated modeling using two scenarios: one without the Global Sulfur Rule in 2020, and one with it included, at different levels of switch volume and light/heavy marine fuel mix. Full compliance with the Global Sulfur Rule will require the removal of approximately 15,000 st/cd of additional sulfur from marine fuel products (TABLE 2). The authors’ modeling does not place this burden solely on additional SRU capacity. It allows for increases in coker throughput, with rejection of sulfur into petroleum coke, limited increases in FCC sulfur oxide (SOx) emissions, limited increases in throughputs on base 2020 SRU capacity (including firm projects), and close to 10,000 st/cd of needed additional SRU capacity.
In short, even allowing for flexibility within the projected 2020 refining system, the authors see a shortfall in SRU—and also H2—capacity needed to achieve full adaptation to the Global Sulfur Rule.
An official IMO study also projected substantial SRU and H2 plant shortages.2 These two sets of modeling analyses beg the question of whether the refining industry is willing and able to “fill the gap,” now that the timing is set for the Global Sulfur Rule implementation. It would need to build significant additional SRU and H2 capacity before 2020. The authors, as well as other industry analysts, are not optimistic that the refining industry will make the required investments to the scale needed, for three main reasons:
- Insufficient time. Historical refining project completion times and discussions with experts in this area indicate a build time of at least 2 yr–3 yr for newbuild SRUs. The authors perceive a low likelihood of new major SRU projects (i.e., those not already in the advanced planning to engineering stage) entering into service by 2020. Significant time is needed to complete a project, from idea inception to startup, even with the ability to deliver skid-mounted and modular units.
- Unclear long-term economics. Economic justification for refining projects is always a key factor. The authors estimate that the necessary incremental SRU and H2 capacity additions needed to fully comply with the Global Sulfur Rule will entail an investment of approximately $5 B. With uncertainty on how the regulation will be met post 2020, it remains to be seen whether sufficient new refining projects will be announced and materialize. Refiners have indicated concern over these projects because of uncertain long-term justification for them. The scenario that puts refiners in a quandary is that a surge in distillate costs in 2020 will lead to a rush by shipowners to install scrubbers. This will, in turn, lead to a partial reversion to high-sulfur marine fuel after a few years. Economic justification for a project must usually extend significantly beyond a 2 yr–5 yr payback window. Therefore, however profitable 2020–2024 may be for building a new SRU, the investment may not make sense.
- Marine fuels not strategically necessary for many refiners. Marine fuels comprise a relatively small percentage of total global liquids demand (an estimated 6% in 2020), and are not a significant driver of refiner planning and investment. While maintaining compliance with regulations for gasoline, onroad diesel and jet fuel is a strategic necessity for nearly all refiners; participation in the marine fuels market is more of an option. Several oil majors are leading suppliers of marine fuels, but other refiners do not participate directly—hence the large and active bunker fuels blending and supply sector. Moreover, while major bunkering centers are located in places such as Houston, Rotterdam, Fujairah and Singapore, volumes sold can be more fluid than those of fuels for inland consumption. Ships can and do alter where they bunker, based on supply and pricing. Therefore, there is not the same onus on many individual refiners to be involved in the marine fuels market as there is for other transportation fuels.
Bunching of refinery projects in 2019 represents a danger
A critical determinant for the refining industry is whether scheduled capacity additions between 2016 and 2019 will materialize in time. The drop in crude oil prices has impacted the timing of refining investments. It has led to the deferral of planned refinery additions, such that now a peak of approximately 1.7 MMbpd of new capacity is projected for 2019 (FIG. 3). This capacity includes projects that have not started construction, adding a concern that any further slippage will exacerbate 2020 marine fuel supply issues.
Fig. 3. Annual distillation capacity additions and total projects investments, 2012–2021.
Potential for widespread economic strain on markets, with winners and losers
In a situation that calls for full compliance in 2020, the authors’ outlook is for severe strain on petroleum product markets. This outlook is based on sharp increases in marine gasoil-intermediate fuel oil (MGO-IFO) price differentials, which translate into higher prices for inland diesel/gasoil, jet fuel, kerosine and gasoline throughout the world because of the coproduct nature of refining. Prices for HS HFO are expected to drop significantly. Initial “spike” differentials could hit or exceed $500/t, $60/bbl for diesel vs. HS HFO.
This points to winners and losers among refiners. Deep-conversion, high-complexity refineries (those able to process high volumes of heavy, sour crude) are clear winners, especially where the orientation is toward distillate yield. Conversely, less complex refineries producing high HS HFO yields look to be losers, with implications for possible additional refinery closures.
Market will ‘clear’—but when and how are uncertain
These predictions of tight/inadequate capacity and severe economic strain raise the question of what will actually happen in 2020. For a start, 100% compliance with the Global Sulfur Rule seems unlikely because of supply tightness and limitations on what the shipping sector can afford to pay for fuel. Also, MARPOL Annex VI allows for waivers in the event of non-availability of compliant fuel.
Equally, enforcement is a prospective issue, opening up the potential for illegal non-compliance. Strained economics could also lead the market to enter into additional adaptations and clearing mechanisms, driven by price elasticity effects:
- Depressed prices for HS HFO could open up more outlets, thereby boosting demand to a limited extent:
- Industrial boiler/power sector (although widespread restrictions on sulfur apply)
- Seasonal demand for asphalt
- Increased prices for diesel/gasoil, jet fuel/kerosine and gasoline could curb demand, but with the associated risk of adverse economic impacts
- A strong market contango on HS HFO could instigate a move to build HFO stocks—effectively following in the footsteps of the crude oil inventory build of recent years
- Over the medium term, increased premiums for light sweet crudes and higher discounts for heavy sour grades could affect supply in regions where production is economically sensitive; think increased production of light sweet oil (notably North American LTO) and lower production of heavy sour crudes (such as Canadian oil sands).
The next scheduled step in the IMO Annex VI process was for an implementation plan to be developed at a meeting of the subcommittee on Pollution, Prevention, and Response (PPR) in late January, with submission to MEPC 71 in July 2017 for approval. This timeline is only part of what is sure to be a long and complex process with far-reaching consequences.
Recognizing the amount of time needed for the shipping and refining industries to adapt—and that the outcome is uncertain, with a lot of “moving parts”—it will be essential for all stakeholders to stay on top of developments. This will entail tracking and evaluating the outlook from the present to 2020 and beyond, with a keen focus on progress in necessary refinery investments, scrubber installations, fuel demand mix, formulations and compatibility, market supply/demand, compliance and price impacts worldwide. HP
- EnSys Energy and Navigistics Consulting, “Supplemental marine fuel availability study,” July 2016, sponsored by IPIECA, BIMCO, CONCAWE/Fuels Europe, Canadian Fuels Association and Petroleum Association of Japan.
- Faber, J., “Assessment of fuel oil availability—final report,” July 2016.
- Field Upgrading, “Ship and bunker update: IMO decides on 2020 for 0.5% global bunker sulfur cap,” October 2016.
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